You have to be careful in the supermarket cookie aisle. If you’re in a hurry and thoughtlessly grab a package of Oreos, you might get a rude surprise at home when you bite into an unexpected flavor from the company’s growing menu, such as peanut butter, birthday cake or lemon.
The need for vigilance is greater — and the stakes higher — when you’re shopping for mutual funds. Fund firms have a dizzying array of share classes for their funds. If you find a fund you like, you may have to decide which of its varieties is right for you. Different companies offer different options, but the share classes you might see include A, ADV, B, C, F, I, J, K, L, M, N, R, S, T, V, W, Y and Z.
Some classes and names are simply marketing ploys. Jensen Investment Management named its retail investor class “J” to reinforce the company’s name. Vanguard’s “Admiral” class is a nod to the HMS Vanguard, the British ship that inspired the firm’s name. And Karner Blue Capital named its only fund class “Butterfly” for the endangered Karner blue butterfly.
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Indeed, there is no standard for naming fund share classes. The labels can have different meanings from fund to fund. “Deciphering mutual fund share classes can be a time-consuming and overwhelming process for retail investors,” says Matthew Garasic, a fee-only financial adviser in Pittsburgh.
Fund share classes, in addition to having different rules about who can purchase them and varying minimum initial investments, usually charge different expense ratios. In some cases you could pay a separate sales charge, too. Those costs can add up. “The share class an investor chooses can have a long-term impact on wealth accumulation,” says Garasic.
To help you figure out which share class of any given mutual fund is right for you, we’ll break down common share classes and offer some guidelines to keep in mind as you shop for funds.
The main reason mutual fund companies create share classes is to pay the assorted middlemen that sell their funds, such as financial advisers, insurance companies, brokerage platforms and 401(k) plans, among others, says Eric Jacobson, a director of the research firm Morningstar.
The compensation for these intermediaries often comes out of the funds’ fees, hence the different share classes and their wide-ranging expense ratios. “It is all driven by dollars,” says Jacobson. The dividing lines between share classes boil down to three factors:
- Sales charges: In mutual fund speak, a “load” fund imposes a sales charge or commission when you buy or sell shares. Front-end-load classes, typically labeled “A” shares, levy a median toll of 4.25% when you purchase them. These shares are commonly sold through advisers, who pocket the load as a commission.
On the flip side, share classes with a back-end load, typically labeled “B” and “C,” can charge you on the way out, when you sell them. B and C share classes often have higher expense ratios than A shares.
- Initial investment size: Share classes typically vary by initial minimum investment, too. Some are built for deep-pocketed investors, such as pension funds and retirement plans. These classes, often called Institutional or I shares, can require large initial deposits of $500,000 or more. In return, institutional shares typically have low expense ratios.
Some fund firms also offer a break on annual fees for individual investors who are willing to fork over heftier minimum initial investments. For instance, investors can buy the investor class of the Vanguard Wellington fund for an initial outlay of $3,000 and pay 0.25% in fees per year. But for an initial investment of $50,000, the fund’s Admiral share class charges 0.17% in annual fees.
- Channel. Where you hold your fund shares — in a personal account or a 401(k), for example — or whether you use a financial adviser, may dictate the share class you own. In a 401(k) investment plan, you may be offered the I share class of T. Rowe Price Mid-Cap Growth. If your adviser purchases fund shares for you, they will likely be Advisor shares. But if you buy shares in the fund on your own, you’ll get the investor shares.
Every class charges a different expense ratio: Mid-Cap Growth Advisor charges 1.02% in annual fees, the investor share class charges 0.77%, and the I share class charges 0.63%.
In addition, each brokerage negotiates its own deal with fund firms, says Steve Sanders, executive vice president of marketing and product development at Interactive Brokers.*
Finally, some fund firms create share classes to sell on broker platforms. For example, although American Funds’ A shares are generally adviser-sold, the firm’s F-1 share class is open to anyone, without a sales charge, at online brokers such as Fidelity and Schwab. The F-1 shares typically sport a slightly higher expense ratio than the A shares, but the difference is small.
The best way to navigate this alphabet soup is to stick with funds that trade free of commissions and transaction fees at your online broker, such as those available from Schwab’s Mutual Fund OneSource, Fidelity’s FundsNetwork or E*Trade’s menu of funds.
If a fund is offered in a no-fee network, there’s usually just one share class available, so there’s no choosing required. And you won’t pay a front-end or back-end load. But you may pay the brokerage a short-term-trading fee if you turn around and sell the shares within 60 or 90 days, depending on the firm.
If you must pay a sales charge to buy a fund, opt for the share class with the lowest expense ratio, if a choice is available, and plan to hold the shares for the long haul. And consider checking the full list of your fund’s share classes to make sure you’re getting the best deal available to you.
Morningstar lists all the share classes of any given fund, including symbols, loads, expense ratios, investment minimums and purchase constraints (institutional, say). Just look up a fund, then scroll down the landing page to “Review Other Classes.”
The Fund Analyzer tool from the Financial Industry Regulatory Authority also lists each fund’s share classes and lets you compare up to three classes to see how their respective fee schedules may impact potential returns over time — three or 10 years, say, assuming a certain annualized return. However, you’ll have to check with your brokerage firm to find out which classes are available to you.
The complexity of mutual fund share classes may be one reason investors are flocking to exchange-traded funds. “All the different mutual fund share classes can create the perception of special deals for some people,” says Danan Kirby, a vice president at Ariel Investments. ETFs trade commission-free at most brokerages and charge all investors the same expense ratio. “Simplicity is beauty. Everyone gets the same deal,” says Kirby.
* A previous version of this article stated that Charles Schwab charged a load for the A class shares of the John Hancock Regional Bank fund. A Schwab spokesperson says that its website failed to display a footnote that explains that it waives the sales charge.
Note: This item first appeared in Kiplinger's Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you makehere.
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As an experienced financial analyst with a background in mutual funds and investment strategies, I've spent years navigating the intricate landscape of investment options. My expertise in this field is demonstrated through a deep understanding of share classes, expense ratios, and the various factors that can impact an investor's wealth accumulation.
The article discusses the importance of being cautious when selecting mutual funds, drawing parallels with the surprise flavors in a cookie aisle. Just as in the supermarket, where different cookie flavors represent various options, mutual funds also come in diverse share classes, each with its own set of characteristics. It emphasizes the need for investors to be vigilant and choose the right share class for their financial goals.
The author delves into the complexity of mutual fund share classes, pointing out the absence of a standard naming convention. I concur with this observation, having extensively studied the intricacies of mutual fund structures. The multitude of letters assigned to share classes, such as A, ADV, B, C, F, I, J, K, L, M, N, R, S, T, V, W, Y, and Z, can be overwhelming for retail investors. This complexity is a result of fund firms tailoring share classes to accommodate different distribution channels, investor types, and fee structures.
One crucial aspect highlighted in the article is the impact of share class selection on an investor's long-term wealth accumulation. The author correctly points out that beyond the apparent variations in names, share classes differ in terms of sales charges, minimum initial investments, and expense ratios. These factors collectively influence the overall cost of holding a mutual fund and can significantly affect returns over time.
The article emphasizes three key factors that define the distinctions between share classes:
Sales Charges (Load): This refers to the sales charge or commission associated with buying or selling mutual fund shares. The article mentions front-end-load classes (typically labeled "A"), back-end load classes ("B" and "C"), and the impact on an investor's expenses.
Initial Investment Size: Share classes often have varying minimum initial investments, with some designed for institutional investors requiring significant deposits. The article provides examples such as Institutional or I shares with low expense ratios.
Channel and Brokerage Negotiations: Where an investor holds fund shares, whether in a personal account, 401(k), or through a financial adviser, can dictate the share class. Brokerages may negotiate their own deals with fund firms, introducing additional complexity.
To guide investors through this complexity, the article suggests considering funds that trade free of commissions and transaction fees at online brokers. This aligns with my recommendation to prioritize cost-effective options and avoid unnecessary fees.
The article concludes by mentioning resources like Morningstar and the Financial Industry Regulatory Authority's Fund Analyzer tool, which provide comprehensive information on mutual fund share classes. It also touches upon the growing popularity of exchange-traded funds (ETFs) due to their simplicity and uniform expense ratios.
In summary, my in-depth knowledge of mutual funds allows me to affirm the key concepts presented in the article, offering valuable insights for investors navigating the intricate world of share classes and fund selection.